Context:

• The decision by the Reserve Bank of India’s Monetary Policy Committee to raise benchmark interest rates again by 25 basis points is a prudent one.

• This is the second successive rate increase in as many months, a response to mounting uncertainties on the inflation front.

• Retail inflation increased to 5% in June.

• The MPC’s main aim is to ensure that retail inflation (CPI) stays within 2 to 6%, and preferably at 4% over the medium term.

Reason behind interest rate hike:

• Volatility in crude oil prices and its vulnerability to geopolitical tensions and supply disruptions is one of the main risks to the inflation outlook.

• Global financial markets are volatile.

• Fiscal problems at the Central and State levels.

• The possible impact of the increase in the minimum support price for kharif crops.

• Impact of upward revisions to house rent allowance paid by State governments.

• Rainfall has so far been 6% below the long-period average and deficient over a wider area than last year — more than a fifth of the country’s 36 sub-divisions have reported shortfalls. This has resulted in a drop in the total sown area under kharif.

Reserve bank of India observation

• The monetary authority has flagged the need to keep a close watch on rain over the remainder of the season, given the risks regional imbalances may pose to paddy output and CPI inflation. The June round of the RBI’s own survey of household inflation expectations reveals that families see prices hardening even further over both the three- and 12-month horizons.

• The domestic economic activity has strengthened to a point where the output gap has ‘virtually closed’, manufacturers polled by the central bank have reported higher input costs and selling prices over the April-June quarter.

• Policymakers on the MPC have understandably spotlighted the risks to the domestic economic rebound from global developments.

• While rising trade protectionism threatens to impact investment flows, disrupt global supply chains and hurt all-around productivity, depreciation in the value of most currencies against the strengthening dollar have rippled through many major advanced and emerging economies, spurring inflation across these markets.

• With inflation widely accepted as a hidden tax on the poor, the containment of price gains justifiably ought to be the raison d’etre of monetary policy.